EXLS

ExlService Holdings, Inc. - Q1 2007 Filing Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2007. ExlService Holdings, Inc. is a provider of offshore solutions, including business process outsourcing (BPO), research and analytics, and advisory services, primarily serving clients in the United States and the United Kingdom. The company completed its initial public offering in October 2006 and acquired Inductis Inc. in July 2006 to expand its research and analytics capabilities. Results for the current period are not fully comparable to the prior year due to the Inductis acquisition.

Key Financial Metrics

Margins: Gross margin improved to 38.6% (from 35.2% in Q1 2006). Operating margin increased to 12.3% (from 6.5%). Net income margin rose to 13.5% (from 8.8%).

Material Changes vs. Prior Period

• Revenue Growth: Revenues increased 84.7% year-over-year, driven by the Inductis acquisition (contributing $4.2 million), organic growth in existing client relationships, and favorable foreign exchange rates.
• Profitability: Net income increased 184.2% to $5.41 million. This was aided by higher revenues, better capacity utilization, and a reduction in interest expense following the repayment of preferred stock and senior promissory notes in late 2006.
• Cash Flow: Operating cash flow turned negative ($8.31 million outflow) compared to a positive $0.29 million in the prior year. This was primarily due to a significant increase in accounts receivable ($8.3 million increase) and a decrease in accrued expenses due to timing of payments and higher bonus payouts.
• Headcount: Employee count grew from 5,799 in March 2006 to approximately 8,966 in March 2007, increasing salary and personnel costs.

Guidance, Outlook, and Risks

• Capital Expenditures: The company expects to incur approximately $11 million to $14.5 million in capital expenditures in 2007, primarily for expanding facilities (including a new Noida facility) and technology.
• Client Concentration Risk: The two largest clients accounted for 27.6% and 23.8% of total revenues in Q1 2007. Norwich Union (27.6%) has an option to purchase the company's Pune facility, which could result in a loss of revenue if exercised.
• Tax Contingencies: The company is disputing three transfer pricing assessment orders from Indian tax authorities totaling approximately $9.4 million in additional taxes. The company has paid $3.9 million in deposits but believes the probability of loss is remote and has not accrued a liability.
• Internal Controls: Management concluded that disclosure controls and procedures were not effective as of March 31, 2007, due to employee turnover, insufficient staffing, and integration complexities with Inductis. Remediation efforts are underway, including the hiring of a new CFO.
• Foreign Exchange: The company remains exposed to fluctuations between the Indian Rupee, U.S. Dollar, and U.K. Pound Sterling, though it utilizes forward contracts to hedge a portion of this risk.

Investor Verification Checklist

• Verify the status of the Indian tax disputes and the potential impact of the $9.4 million assessment orders on future cash flows.
• Monitor the remediation of internal controls and the effectiveness of the new CFO in stabilizing financial reporting.
• Assess the risk of revenue loss if major client Norwich Union exercises its option to assume operations of the Pune facility.
• Review the accounts receivable collection timeline, given the $8.3 million increase in receivables and the negative operating cash flow.
• Track the utilization rates of the new Noida facility and other capital investments to ensure they do not negatively impact operating margins.